Prospects for sterling recovery

Overseas buyers and a cheaper pound

by John Plender

Wed 13 Jul 2016

With British politics stabilising quicker than expected after the European Union referendum three weeks ago, the position of sterling – now at much lower levels than on 23 June – looks a lot stronger than many experts originally thought.

The pound could even suffer the fate of the yen by becoming firmer than the UK authorities wish. After the devaluation wrought initially by the economic policies of Japanese Prime Minister Shinzo Abe, the yen is back to being a haven currency. In a similar way, there is a much greater probability of recovery than panic for sterling in coming months.

Britain’s post-referendum devaluation has provided an opportunity to secure a larger share of global demand without incurring international opprobrium. Given sterling’s previous overvaluation and a current account deficit running at more than 5% of GDP, this makes the task of rebalancing the economy away from consumption towards manufacturing less of a challenge than hitherto.

For many international investors, sterling assets now look cheap. Overseas buyers are closely watching the UK commercial property market, where open-ended funds are being pushed into forced sales to deal with redemptions. With good property likely to become available at discounts of up to 20% in a cheapened currency, the opportunities will be compelling.

Similarly, AMC, the US chain owned by Chinese entertainment conglomerate Dalian Wanda, has agreed a £921m acquisition of the UK’s Odeon cinema group – making it the world’s biggest cinema operator – in a deal partly driven by the pound’s fall to a three-decade low against the dollar.

The historical parallels are intriguing. When Britain left the gold standard in September 1931, sterling fell 30% before finding a floor in December that year. That was the point at which foreign investors concluded the pound was cheap.

To a degree their bet was self-fulfilling. The resulting inflow of capital contributed to a rapid expansion in broad money. In 1932-38 Britain enjoyed one of its fastest growth spurts in the 20th Century.

At the beginning of this week, sterling had fallen 13.5% against the dollar from its pre-referendum level. So if the parallel were exact, the pound would have a long way to fall. Yet the differences between the two episodes suggest a much less dramatic outcome.

For a start, the external environment is much less gloomy than in the 1930s, with the US continuing to lead a global recovery in the wake of the financial crisis. After last week’s impressively robust non-farm payroll numbers, concern about a US slowdown looks to have been premature. Growth in the euro area has been less feeble than many forecasters expected. China continues to grow relatively fast.

The extent of sterling’s fall more than compensates for the tariff burden that most British exporters would face in the EU if a trade deal were forged with Brussels on a minimal World Trade Organisation basis. Note, too, that a smaller banking system would pose less of a toxic threat to the economy and the taxpayer.

The benefits of devaluation to the current account will be less striking than in the 1930s because British exports today, whether in services or high-end manufacturing, are less price sensitive. But much of the deficit stems from the fall in the returns from Britain’s overseas investments. These returns will now receive a devaluation boost.

That said, despite much gloom-mongering about the current account deficit, there is a sterling rate at which the deficit will be financed without undue problems. It could be that we are less far from that level than many pundits think.

John Plender is Chairman of OMFIF. This is an edited version of an article published by the author in the Financial Times on 12 July.